Every commercial real estate investor is unique. They have different levels of risk tolerance, different investment objectives, and different return requirements. When considering the suitability of an investment for any one individual, it is important that their unique needs be given proper consideration.
In this article, one of those unique needs – the time horizon – is discussed in detail. Once finished, readers will have a greater appreciation for the importance of the time frame in an investment decision.
At First National Realty Partners, we work with each one of our investors to understand their time horizon and investment requirements to ensure that our investment offerings are suitable for their needs. For more information on our current investment opportunities, click here.
What is a Time Horizon?
An investor’s “time horizon” – also referred to as their time frame or desired holding period – is the amount of time that they are willing to hold an investment before their capital is returned (with interest).
How Are Time Horizons Categorized?
For the sake of discussion, time horizons are categorized into short, medium, and long terms.
Short Term Time Horizon
Generally, a short term time horizon is between 1 day and 10 years. Common examples of investments with a short term investment horizon are things like savings accounts, money market accounts, certificates of deposit, and short duration bonds.
Medium Term Time Horizon
A medium term time horizon is between 10 to 20 years. Examples of medium term investments include things like medium duration bonds, common stock, and real estate.
Long Term Time Horizon
A long term time horizon is any investment that has an estimated return period of greater than 20 years. Examples of investments that have a long term time horizon are things like real estate development projects, long duration bonds, and annuities.
These time distinctions may seem like an elementary concept, but it is a critically important one.
Why The Time Horizon Is Important
An investor’s time horizon is important for three reasons: suitability, returns, and risk.
The first, and perhaps most significant, reason that the time horizon is important is because it is a major factor in determining a real estate investment’s suitability for a given individual. If an individual needs their capital back in 2 years, then a long-term investment is not suitable for their needs, they need something with more liquidity. Conversely, if they have a longer term time horizon, a short-term investment is also not a good fit for their needs. In short, the time horizon of a given investment opportunity should be matched to an individual’s time horizon to ensure it is suitable for their needs.
The time horizon is also a major factor in determining the amount of an investment’s return. In general, the longer an investment’s time horizon, the higher the potential return. Conversely, the shorter the time horizon, the lower the return. This is due to the effects of compounding as well as the ability to take longer term risks with projects that may take some time to pay off. For example, a long term investment could be something like an annuity or a large, multi-phase real estate development project. A short term commercial real estate investment could be a mutual fund, savings account, or certificates of deposit.
Finally, the reason that longer term investments tend to pay more is that they carry more risk and investors need to be compensated for taking it. Over the course of 30 years, there are many unknown factors that could cause significant volatility in an investment’s return. For example, think about how much the stock market has risen and fallen over the course of the past 30 years, even if the long term trend is up.
5 Factors That Impact An Investor’s Time Horizon
Each individual’s time horizon is different and there are a number of factors that can be used to determine what it is. They include age, income, lifestyle, risk tolerance, and liquidity needs. Each of these are discussed in detail below.
1. Age
In general, the younger a commercial real estate investor is, the longer the time horizon they have. Conversely, the older an investor is, the less time they have to wait to receive their money back. For example, a 30-year old investor would likely be a decent fit for a private real estate investment that takes 10 years to return their money. This same opportunity would likely not be as suitable for a 70-year old investor.
2. Income
Fundamentally, income is closely correlated with risk tolerance. An individual with a stable, high paying job can afford to pursue an investment strategy with a long term time horizon because they can feel more certain that they won’t suddenly need their invested capital. At the other end of the spectrum, an investor with a more modest income or one that is highly variable may not be able to take a long term approach due to the uncertainty in their financial needs.
3. Lifestyle
Lifestyle is closely correlated with expenses. The more money that an individual makes, the more they tend to spend. This is known as “lifestyle creep” and it can impact an investor’s time horizon. A commercial real estate investor who has a significant amount of lifestyle expenses like food, travel, cars, and entertainment will likely have a shorter term time horizon than a compulsive saver, who may be able to afford to invest over a longer period of time.
4. Risk Tolerance
Every individual has a different comfort level with risk and they tend to construct their investment portfolio accordingly. If an individual can tolerate high risk, they may achieve a higher returns, but this will also require a longer time horizon. Risky investments include things like real estate development projects, common stock, and crypto currency. At the other end of the spectrum, individuals with a lower level of risk tolerance will likely be more suitable for short and medium term investments. These could include things like single tenant real estate and short duration bonds.
5. Liquidity Needs
An individual’s liquidity need may be one of the most important elements in determining their time horizon. If an individual needs their capital back in the near future, they will be less suitable for any type of commercial real estate investment that has a long term requirement. Conversely, if an individual does not need their money for a long period of time, they could pursue investment options that require a long term commitment.
For example, suppose a parent starts a college fund for their newborn child, which means they know the funds will not be needed until they are 18. With this type-of long term goal, they can afford to be long term investors. But, if that same fund was going to be used for home improvements in 3 years, the length of time they want to invest will be much shorter.
Summary & Conclusion
A commercial real estate investment’s time horizon is the amount of time that it takes for an individual to receive their original capital – plus interest – back. The time horizon is an important component of determining an investment’s level of suitability for an individual and the amount of risk that it represents. Safer investments tend to have a shorter term time horizon while riskier investments tend to have a longer term time horizon.
When an individual is trying to determine whether or not an investment is suitable for their financial goals, one of the first questions that they should ask themselves is, “what is my time horizon?” The answer will be different for everyone, but there are several factors that should be considered including: age, income, lifestyle, risk tolerance, and liquidity needs.
In the investing world, it is common for individuals to look for the “best” investment. We tend to shy away from this designation because there are many different types of profitable investment opportunities. Instead, we encourage investors to look for investments that offer the “best fit” for their own objectives, return expectations, and time horizon.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
